“An unanticipated shift to contractionary monetary policy would lead to currency appreciation. The contractionary policy leads to lower economic growth, a lower inflation rate, and higher real interest rates. Domestic products are less expensive, foreign investment is encouraged, and exports increase.” My understanding: Currency appreciation: due to increased rates Lower economic growth: due to increased rates Lower inflation: due to increased rates and less growth Higher real interest rates: an effect of contractionary monetary policy Domestic products are less expensive: due to lower inflation Foreign investment is encouraged: due to stronger home currency Exports increase: this is the one I can’t figure out. If currency appreciates, shouldn’t exports decrease?
It seems as if the rationale for exports increasing is that lower economic growth means people in your country demand less imports, so NET exports go up. Also, lower inflation means that it is cheaper for foreigners to buy your products. I get this, just feel uneasy still about the fact that we see currency appreciation but still see exports increase, since a key concept is that home currency appreciation is bad for exporters.
Imports should increase , because domestic currency buys more foreign goods. Exports should decrease because foreigners cannot afford costly goods anymore. So it is contradictory , without some sort of price supports ( tariffs for imports , subsidy for exports)
no its right the way its written. - imports go down because theres less economic growth due to higher rates - exports go up due to low inflation (this is also per schweser book 1 page 331)…but at the same time i can see why exports would go down, since a stronger currency would mean less foreigners want to buy your exports
really, I don’t understand this part. There are arguments to back whatever. Pls I will appreciate someone with strong background in economics or thorough understanding of this concept throw more light on both expansionary and contraction.
Expansionary MP 1. Money Supply Up, IR being to fall = promote liquidity in mkt 2. Imports Rise bc we “think” we have more money to buy foreign goods 3. Current FX rate declines offsetting global rates so imports rise AND cost more! 4. Exports should increase if the fx declines to a point where the differential mirrors inflation. 5. inflationary pressure --currency depreciates.
northeastern, look at page 331 in schweser. it says that expansionary monetary policy causes greater demand for imports and LESS demand for exports. the whole really difficult and frustrating issue with this topic is that events occur one after another, so depending on what part of the “chain” you start at, you’ll get a diff answer.
- Imports Rise bc we “think” we have more money to buy foreign goods yet in reality once the fx adjusts we dont. Export demand should decline given the relative value of the goods is less, BUT if the fx doesnt adjust export can go either way… whoa is me! good call “NY” the chain really puts things in perspective, i hate vague theory, like if the CFAI included time periods of contracting/expan policy along with net account figures they could show us!! thats what i want to see
yes the export bit is the one issue i still dont get. expansionary MP causes a depreciating currency, so i cannot see why exports are going up (although i do see why net exports go up since imports go up)
the show NY Wrote: ------------------------------------------------------- > yes the export bit is the one issue i still dont > get. expansionary MP causes a depreciating > currency, so i cannot see why exports are going up > (although i do see why net exports go up since > imports go up) Wont this make your goods cheaper to world?
The way I see it is: With Contractionary Monetary Policy: Immediate effect is, Higher Interest Rates and Lower Inflation, which means Higher Real Interest Rates. Now, because of Higher Real Interest Rates and Lower Inflation: 1. Higher Real Interest Rates will cause foreign capital to come in to the country. (Financial Account - Surplus) 2. And Lower Inflation (lower prices) of goods will increase foreign demand for our goods and hence exports will increase. (Current Account - Surplus) Subsequently, because of the above 2, the Demand for domestic Currency increases and hence it Appreciates. Like ‘the show NY’ said, the sequence of events is important. What you are thinking is effect of Currency Appreciation on Exports. But, what we need to think of is the forces that have appreciated the currency in the first place.
rus1bus, what you said above makes sense to me, but how do you reconciliate this with the fact that currency appreciation decreases exports? It seems like there are two competing forces on exports: increase due to lower inflation but decrease due to stronger currency.